Likely Heavy Inflow of Foreign Exchange: Implications 

Inviting Captains of Industry to Invest in India
Speaking at the Bloomberg Global Business Forum in New York, on 25th September 2019, Shri Narendra Modi, Honourable Prime Minister of India invited global corporate leaders in USA to invest in India. He said historic reductions in corporate tax rates by Govt. of India and after taking many more measures to improve business climate now offer a golden opportunity for investment in India. He tried to motivate movers and  shakers of business world by saying "If you want to invest in a market, where there is scale, come to India. If you want to invest in start-ups with a huge market, come to India. If you want to invest for urbanisation, come to India. If you want to invest in one of the world's largest infrastructure ecosystem, come to India.” He also said that India has opened its defence industry, like never before, and hence invited investments in this field, as well. He also told them about 4D factors - Democracy, Demography, Demand and  Decisiveness, that put together makes India reliable and unique investment destination.
It is true that Govt. of India has taken many steps for improving the business environment in the country. In its second term, the Govt. has repealed 50 laws to further improve the ease of doing business. The Govt. of India respects the business world and values wealth        creation. The Govt. has been taking big and hard decisions. It is as such quite likely that honchos of business in the world may start investing in India. Saudi Arabia has already declared its intentions for investing $ 100 billion in India. Similarly, in view of emerging trade war between China and USA, many corporate leaders are relocating its             manufacturing units from China to other emerging economies. India may become a great beneficiary, as India has very recently taken many steps for attracting foreign investment into India and as a result it has received foreign direct investment of $ 286 billion during the last 5 years, which is half of what it got during the previous 20 years. India by adding $ 1 trillion to its economy during the last 5 years has taken the size of the economy to      $ 2.70 trillion at current prices as at the end of March 2019. Now it is aiming to become a $ 5 trillion economy by 2024-25.

Steps Taken to Attract FDI
In September 2019, Corporate Tax rates have significantly been reduced to 25% from nearly 35% thus taking India nearly at par with major global economies on the tax     network, and the Indian taxation system has been made more transparent and far less   dependent over discretion and far less prone to litigation in a sense that companies that wish to avail themselves of the lower taxation rate would have to give up all the           exemptions hence come clean and avail of the benefit of lower taxation rate regime. These rates are now comparable with the prevailing rate in Asian Economies in particular. The new companies, which set up manufacturing units in India after 01st October 2019 will be required to pay even reduced corporate tax rate of 15%, it is as attractive as     prevailed in Singapore and Hong Kong. Govt. of India has opened FDI in aviation, media and insurance sectors recently. India is now likely to get into Regional Comprehensive Economic Partnership Treaty (RCEP). It is going to give the country an opportunity to get investment from Europe and US for setting up manufacturing units in India and     explore the Chinese market. It is an attraction to those foreign companies who wish to come to India and use the RCEP and explore Chinese market. 
Hospitals, Real Estate, Food Processing Industries are attractive destinations in India to invest in. Investments in Infrastructure will be categorised as investment in                manufacturing, as such will attract corporate tax rate of 15% hence that is one area where one can expect lot of action. There is huge area of defence manufacturing in our country. There is huge unmet defence demand. Foreign investors may like to shift their base to India to meet defence demand of India and if this policy supplements it with the proper Real Exchange Rate Policy then India can become export hub of defence products.     Foreign Companies will come to India Add value and export. MAT system also has been     simplified this will encourage investments in services sector. Ease of doing business is also playing its role, as corporates can set up their shops by getting required facilities and permissions very quickly. The Prime Minister has assured foreign investors to act as a bridge between investors and the concerned agency in India to overcome the problem of investors, if any. This will bode well with the foreign investors. 

Basic structure has been created based on which foreign investors can now come to India to take advantage of friendly tax environment in the country. As such, India now has   become one of the most attractive emerging market destinations from FDI point of view. The Govt. of India is aiming to achieve USD 100 billion worth of FDI annually. 



Recent Significant FDI Announcements

Saudi Arabia Government has announced its intentions to invest USD 100 billion in    India. 
Many American Companies are planning to shift their manufacturing units from China to India in view of undergoing trade war between China and USA.
International Finance Corporation (IFC), the investment arm of the World Bank Group, is planning to invest about USD 6 billion through 2022 in several sustainable and renewable energy programmes in India.
VMware, a leading software innovating enterprise of US has announced investment of USD 2 billion in India by 2023.
Ikea is planning to invest in India for setting up multi-format stores and experience     centres upto USD 612 million. 
Warburg Pincus, USA is likely to buy 20 per cent stake in DTH arm of Bharti Airtel at USD 350 million.
Saudi Aramco will buy a 20 per cent stake in Reliance Industries Ltd. at USD 75 billion.


If Inflow of Foreign Funds Increases Substantially

Looking at the developments enumerated above, it is most likely that the inflow of      foreign funds in the country is going to increase substantially. Higher inflow of foreign funds will result in substantial increase in forex reserves in the country. These funds, apart from other uses, are normally deployed by the Central Bank in the Govt. securities in the international market at low rate of interest. Now the question arises as what should be the ideal level of forex reserves to be maintained by a country. 

Second, with the higher inflow of foreign currency, the market value of rupee vis-a-vis dollar (exchange rate) will strengthen. This may not be liked by exporters as their     products would become uncompetitive in the international market.    

Third, whether forex reserves can be used in the country domestically, where rate of    interest is high, instead of investing the same in the international market, where rate of interest is low.  


Ideal Level of Forex Reserves 
There has been continuous discussions at the international fora about the ideal level of forex reserves to be maintained by a nation. Traditionally the level of reserves has been mainly linked to import requirements of the nation. 
The RBI in its Annual Report for the year 1996-97 has stated that “in the context of the changing interface with the external sector and the importance of the capital account,  reserve adequacy needs to be evaluated in terms of indicators other than conventional norms. Thus, even if exchange market developments accentuate the leads and lags in   external receipts and payments the reserves should be adequate to withstand both cyclical and unanticipated shocks. Furthermore, in the context of fluctuating capital flows, it is useful to assess the level of reserves in terms of the volume of short-term debt which can be covered by the reserves.” 
The RBI in its Annual Report for the year 1997-98 reiterated that “from the standpoint of achieving the goal of ensuring orderly conditions in the foreign exchange market and also to deal with situations arising on account of unanticipated and sudden reversals of capital flows, a level of reserve assets that could be considered as adequate needs to take into consideration a host of factors such as the cover for sufficient months of current        payments, the stock of short-term and volatile external liabilities, shift in the pattern of leads and lags in payments/receipts during exchange market uncertainties along with the conventional norm of cover for sufficient months of imports.” 
The above two paragraphs are giving sufficient hints for maintaining the level of forex reserves by a country. However, the judgement about ideal level of Forex Reserves to be maintained by the Central Bank should be taken judiciously.  Besides the size of reserves, the quality of reserves also assumes importance. Unencumbered reserve assets must be available to the Central Bank at any point in time for fulfilling various objectives         assigned to it. Forex Reserves in our country as on 27th September 2019 stood at USD 433.6 billion, which is equivalent to more than 10 months of imports. 

Exchange Rate 
In India, market forces of demand and supply are determining the exchange rate of     Rupee. The objectives and purposes of exchange rate management, as has been explained by Dr. Y.V.Reddy in a paper, are to ensure that  economic fundamentals are reflected in the external value of the rupee as evidenced by a sustainable current account deficit.  Subject to this general objective, the conduct of exchange rate policy is guided by three major purposes: (i) to reduce excess volatility in exchange rates, while ensuring that the movements are orderly and calibrated; (ii) to help maintain an adequate level of foreign exchange reserves; and, (iii) to help eliminate market constraints with a view to the     development of a healthy foreign exchange market. 
If a country don’t have a proper market linked exchange rate policy in place, this         situation may become a hinderance for orderly development of forex market. The nation may face a diseases, where huge amount of foreign currency flows into India and RBI finds it difficult to keep the value of Rupees depreciated, which may go against interest of exporters and in the process exports from India may become uncompetitive in the        international market. 

According to a report, the Real Effective Exchange Rate (REER) of the rupee, with 2004-05 as the base year for a basket of the six currencies, is overvalued by 24.6 per cent and against 36 currencies, the overvaluation is 18.5 per cent. In some quarters, this          overvaluation is explained as a result of higher Indian productivity. But, the probable   explanation could be that in recent years, net inflows of foreign exchange on the capital account have more than met shortfalls on the current account, leading to accretion of forex reserves, and thus pushing up the rupee to high levels. 
One more theory doing the rounds is that rupee was valued at 71 against US dollar in 2013; it is again almost at the same level in September 2019. If we take annual average       inflation differential between India and USA during the period of last six years at 4% then Rupee is overvalued by 24%. The overvalued Rupee not only hits very hard to exporters but also to those who have deposited dollars in our country.
Reserve Bank of India in our country is playing its role very effectively while monitoring the exchange rate of Rupee. However, in view of the likely substantially increased inflow of foreign currency, it may have to even work very hard to safeguard the interest of     exporters by balancing the exchange rate in the market, even though today the same is determined by market forces of demand and supply. 

Domestic Use of Forex Reserves
It is also sometimes argued that the country should not increase its borrowings in foreign   currency when there is a build-up of foreign exchange reserves, since the return on      reserves is less than the cost of debt. But it must be noted that the level of reserves       satisfies the need for liquidity, offers insulation against unforeseen shocks and acts as a source of comfort to foreign investors. The essence of reserves management being safety and liquidity, all the investments made thereof are of highest credit quality and excellent liquidity and are usually short-term. Hence, the return on reserves and the cost of        borrowing are not strictly comparable, though they need to be considered relevant if a borrowing is meant merely to shore up the reserves.
The argument that after maintaining sufficient level of forex reserves by our country, the excess amount of forex reserves should be used in our own country with a view to       enhancing the flow of currency in the local market instead of investing the same in the international market at very low rate of interest, needs to be discussed in the country at length. After discussing pros and cons for using forex reserves (after maintaining         sufficient level)  in our own country, a policy may be framed, as these funds may work as a buffer for additional capital to be used for furthering the economic growth of India.